What is the windfall tax and how would it work?

How will it work?

Mr Sunak is introducing a temporary 25pc ‘Energy Profits Levy’ to reflect the “extraordinary profits” reaped in by oil and gas companies.

They now face an overall headline tax rate of 65pc, which is a combination of corporation tax – currently at 19pc – existing additional levies and the windfall tax. This stands far higher than companies in other sectors which currently pay the 19pc corporation tax. Some sectors do have additional charges, such as a banking surcharge of 8pc.

The new tax will only impact profits made after May 26, 2022, and will be “phased out when oil and gas prices return to historically more normal prices”.  

Official documents accompanying the announcement say it could last until 2026, with a clause removing the tax on December 31, 2025.

It is expected to raise about £5bn in its first year, according to the Treasury, and will be calculated in a “similar way” to existing corporation taxes. It will not apply to the electricity generation sector.

The levy also includes an Investment Allowance, which will attempt to incentivise those energy businesses into spending money by offering 91p of tax relief for every £1 they invest. 

In theory, oil and gas companies significantly ramping up investment would result in them being given large amounts of relief, which could partially offset the boost to the Treasury’s coffers from the windfall tax.

How does the tax work in other countries?

This is not unprecedented. Other countries have previously turned to windfall taxes to ease the pressure on household budgets.

Last September when gas prices first soared, Pedro Sanchez’s left-wing government in Spain announced a €3bn (£2.6bn) windfall tax on energy companies’ “excess profits” to help pay for tax cuts for consumers.

Italy has also imposed extra taxes on utilities’ profits. Last month it announced a 10pc windfall tax on some energy companies to finance household aid with the country heavily reliant on Russian gas.

What has the UK done before?

It is also not the first time the UK Treasury has reached for a raid on companies with ballooning profits.

In 1997, then-Chancellor Gordon Brown announced a windfall tax on the “excess profits” of utilities following their privatisation by previous Conservative governments. It aimed to rectify the “bad deal which customers and taxpayers got from the privatisation of the utilities”.

The £5bn raised was used to fund a welfare-to-work scheme known as the “New Deal”, which aimed to cut unemployment.

In 1981, meanwhile, Margaret Thatcher placed a 2.5pc windfall tax on banks as interest rates soared. It raised £400m, about £3bn in today’s money.

What do critics say?

Opponents of windfall taxes warn it could hamper investment at a time when the UK is trying to boost spending to shore up the country’s energy supplies in the wake of Putin’s war.

BP chief executive Bernard Looney said that a windfall tax is not “going to incentivise more investment” and many ministers agree. In March this year, Kwasi Kwarteng warned the plans would be “a tax on jobs, would destroy investment and would add to the uncertainty in oil markets”.

Earlier this month, the Business Secretary added that the tax “doesn’t make sense” if Britain wants to encourage investment in the North Sea and have domestic energy supply sources.

Many fear it could also send a bad signal to foreign investors if they believe that bumper profits in future could be targeted.

Critics also highlight that pensioners often benefit from the profits of oil giants as pension funds own shares in them.

This article is kept updated with the latest information.